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USDA vs. conventional loan: Which is right for you?

Yahoo Personal Finance· Getty Images
8 min read

Though the conventional loan is the most common type of mortgage, it’s not the only choice for borrowers. A lesser-known option worth exploring is the USDA loan program run by the U.S. Department of Agriculture. If you qualify for this government-backed mortgage, you could buy a home without any down payment.

Here’s what you need to know about USDA loans versus conventional ones before shopping for mortgages.

Read more: The best mortgage lenders for first-time home buyers

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USDA loans are zero-down-payment home loans insured by the United States Department of Agriculture. They’re designed for borrowers with low-to-moderate incomes who want to buy homes in rural areas and small towns. To qualify for a USDA loan, the home you’re buying must be in an eligible area, and your income must fall within program guidelines.

Unlike USDA loans, conventional loans aren’t insured by any government agency, making it riskier for mortgage lenders to provide them. And because there's no government guarantee, requirements are typically stricter for conventional mortgages than USDA loans.

Conventional loans can be conforming or nonconforming. Conforming loans meet standards set by government-sponsored entities (GSEs) Fannie Mae and Freddie Mac and are within the lending amounts set by the Federal Housing Finance Agency (FHFA). On the other hand, non-conforming mortgages (specifically jumbo loans) exceed those limits.

Dig deeper: How does a jumbo loan work?

USDA loans are insured by the government while conventional loans are not, so it makes sense that they have different underwriting, credit score, down payment, and mortgage insurance requirements. Here’s a more detailed view of the differences between the two types of mortgage loans to help you understand which is right for you.

The application and underwriting process for conventional loans usually takes between 30 and 60 days since everyone’s situation differs. Just make sure to provide all the documents required to avoid any delays.

This process might take longer for USDA loans since the agency may have to review your mortgage lender’s underwriting under certain circumstances. If your credit score is lower than 640, your application may undergo manual underwriting, which could also drag out the process.

Conventional loans don’t cap how much you can earn annually to qualify, but USDA loans are pretty strict about income since they are specifically designed for low-to-moderate-income households. The exact income rules depend on your property location and household size. Check the income limits for the county where you plan to buy to see if you qualify.

Though not always the case, most lenders require you to have at least a 620 credit score to qualify for conventional loans. Generally, the higher your credit score, the better your chances of getting approved for a conventional loan with a favorable rate.

While the USDA doesn’t set a minimum credit score to buy a house, it’s common for USDA lenders to prefer borrowers with a FICO score of at least 640. If you have a lower score, it’s still worth shopping around since each lender has its own preferences. Some will even allow a credit score as low as 580.

Read more: Getting a mortgage with good (but not great) credit

Down payment requirements for conventional loans vary depending on the lender and the type of conventional loan you’re using. It could be as little as 3% with Freddie Mac Home Possible? or Fannie Mae HomeReady? loans. But if you’re taking out a jumbo loan, expect to put at least 10% down.

USDA mortgages don’t require down payments — perhaps the biggest perk of this type of mortgage loan.

Each year, the Federal Housing Finance Agency (FHFA) publishes conforming loan limits that apply to all conforming conventional loans. These loan limits cap the amount you can borrow for a house. For 2024, the conforming loan limit for one-unit single-family homes is $766,550, with higher-cost areas at $1,149,825.

Like conventional loans, the maximum lending amounts for USDA loans also vary depending on where you live. For 2024, the USDA loan limit in most places is $398,600, but it can be higher in more expensive areas. Find your county’s borrowing limit here.

A home appraisal is an unbiased assessment of a home's fair market value, and it’s required for both conventional and USDA loans.

If you use a USDA loan to finance your home, the appraiser must confirm that the property is not only correctly valued but also habitable and in a USDA-determined rural area. Conventional loan appraisers do not have to hold a home to the USDA's strict standards.

With conventional loans, you must usually pay private mortgage insurance (PMI) if your down payment is less than 20% of the home’s purchase price. PMI protects your lender if you default on your loan. According to the government-sponsored entity Freddie Mac, you can expect to shell out between $30 and $70 monthly per $100,000 financed.

Strictly speaking, USDA loans don’t come with mortgage insurance. However, you still must pay a USDA guarantee fee (which is similar to mortgage insurance) at closing and each month for the life of your loan. This fee helps the USDA make these mortgages available. The up-front guarantee fee, which is typically 1% of your total loan amount, is paid at closing. You’ll also pay an annual guarantee fee — 0.35% of your outstanding principal balance — that’s divided by 12 and included in your monthly mortgage payment.

Dig deeper: What is mortgage insurance, and how does it work?

USDA loans offer many benefits if you qualify, but remember to also consider the downsides before going with this mortgage option.

  • Low interest rate. Since the government insures USDA loans, mortgage lenders assume less risk and can afford to keep the interest rates low.

  • Low insurance cost. The USDA mortgage guarantee fee costs 1% of your loan at closing and 0.35% of the remaining balance each year, whereas PMI for conventional loans typically costs 0.50% to 1.50% of your mortgage annually, divided into monthly payments.

  • No down payment requirement. USDA loans allow you to finance up to 100% of a home's appraised value, which is probably the biggest perk of this loan option.

  • Primary residences only. You can only use USDA loans to finance primary residences, whereas conventional loans also allow you to buy investment properties or second homes.

  • Household income restrictions. USDA loans are designed to help low-to-moderate-income buyers find homes, so you won’t qualify if your household income is too high.

  • Location requirements. To be eligible for USDA financing, your home must be in a rural part of the country. This means USDA loans may not be for you if you plan to buy a property in a major city.

  • No way to cancel the guarantee fee. Yes, the USDA guarantee fee is more affordable than PMI on conventional loans. However, there are several ways to waive PMI or cancel it after a certain period of time — with a USDA loan, you’ll pay the guarantee fee no matter what and for the entire life of the loan.

If you're still unsure whether a conventional loan is a better fit than a USDA loan, consider these pros and cons of conventional mortgages.

  • No household income restrictions. Unlike USDA loans that restrict how much you can make to qualify for financing, conventional loans have no maximum income limit.

  • You can borrow more money. If you meet the jumbo loan qualifying requirements, you can take out loans that exceed the conforming limits set by the Federal Housing Finance Agency (FHFA).

  • Flexibility on loan terms. Conventional loans typically have many loan terms and let you choose between fixed-rate and adjustable-rate mortgages. USDA loans only allow for fixed-rate mortgages.

  • Stricter eligibility requirements. Since the government does not back conventional loans, lenders may impose stricter eligibility requirements, such as higher credit score minimums, to filter out people with high default risk.

  • Higher interest rates for those with bad credit. Another downside of conventional loans is that the rates may be higher for people with less-than-great credit scores than with other types of mortgages.

  • PMI premiums. You have to pay private mortgage insurance if you put less than 20% down, increasing your homeownership cost.

The short answer is: It depends. Conventional loans can be a great option if you have excellent credit, especially if you can make a 20% down payment to avoid private mortgage insurance and snag a lower interest rate. You also don’t have to deal with the USDA restrictions on where your home is located.

On the other hand, you may want to go with a USDA loan if you plan to settle down in a rural area and want to put 0% down.

Read more:

To get a USDA loan, you must submit an application to one of the USDA's approved lenders. Remember to shop around first to get the best loan terms.

Yes, you can refinance out of your USDA-guaranteed loan and into a different loan type, such as a conventional loan, as long as you meet the lender’s requirements and have a certain amount of equity in your home. You can also replace your existing USDA loan with a new USDA loan that has a better rate or terms by taking advantage of the USDA streamlined refinance program.

You can pay off both conventional and USDA loans early. However, conventional loans may have prepayment penalties, while USDA loans do not.

This article was edited by Laura Grace Tarpley.